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Don't Risk Your Startup For A Couple Of Equity Points

Lucas Pols is the CEO and Founder of Spark xyz. He is a writer, traveler, entrepreneur, mentor and angel investor.

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From my point of view as a venture capitalist, I have realized that many startups share a common struggle: how to determine valuation. There are plenty of articles on how to value your specific startup and the different methodologies behind it, but what many of them neglect to recognize is that for most early-stage (pre-seed) startups, valuation is most likely determined by the surrounding market, or by the investor themselves (hence the abundant use of convertible notes).

Going with the market rate — analyzing similar startups in your industry and considering what they raised — can be an excellent solution. But first, you need to think through these two considerations.

Market Saturation

If you raise capital in Silicon Valley, there is a good chance you won't be able to raise capital in a different market such as Los Angeles, New York or Boston. That's because Silicon Valley has too much wealth, and sometimes, it shows in the actions of investors. For example, I've seen Silicon Valley venture capitalists decide they want to invest in Founder A, so they add Founder B (a direct competitor) on LinkedIn, just to throw off any investors who might be looking into Founder A's deal. That's the tip of the iceberg when it comes to actions that teeter on the edge of insanity and brilliance, but it's a function of a market that has too much capital.

If you are in a market that has an overabundance of capital, it will drive your valuation higher than it should be. From a founder's perspective, your first thought is probably to move immediately to Silicon Valley and raise capital there, because you'll end up being less diluted in the long run. But I would caution you that as a founder, you need to think honestly through the implications of raising capital and at what valuation.

If you do raise capital in an oversaturated market, you're going to be stuck in that ecosystem. If you raise your earlier rounds outside of Silicon Valley and then you transition there for Series A and B, you might have a better chance of weathering bumps in the road on the way to those specific rounds.

Overvaluation

If you overvalue your company, you're going to be stuck trying to catch up to that crazy valuation. Do you know what happens when you don't hit your metrics? You have a down round, and the down round is the kiss of death for the founder's equity pool. Those couple of points you saved by overvaluing your company, unfortunately, are next to worthless (assuming you can even raise a down round). Next will be liquidation preferences, a board takeover and gutting your management team — including you as the CEO.

When you're raising money, ask yourself this question: Is this truly a fair assessment? I can tell you from going through 1,500 pitch decks last month alone that this is not a question that is asked often enough. I encourage everyone to take a hard look at what happens when you go down this path, and whether a couple of points of equity are worth the risk of your entire venture.